U.S. midterms: what they mean for investors

Democrats have won control of both the House and Senate in the U.S. midterm elections, shifting the balance of power in Washington after flipping key Republican-held seats across the country. The outcome could make it harder for President Donald Trump to advance new legislation. Although his administration has already relied heavily on executive and regulatory action to pursue its agenda – including on trade, immigration and deregulation – Democratic control of both chambers of Congress will now give the party greater leverage over presidential appointments and federal spending.

Fiscal policy may prove to be the bigger flashpoint. Divided government raises the risk of funding standoffs and government shutdowns. Debt ceiling negotiations could also become more contentious, though the outgoing Congress may seek to address the issue before its term ends in early January. Either way, gridlock is unlikely to alter the U.S. fiscal trajectory. Large deficits and heavy government borrowing are likely to persist, intensifying competition for capital and reinforcing our view of structurally higher interest rates. Historically, policy gridlock has not been bad for risk assets. Debt ceiling standoffs have been the bigger source of market volatility.

Beyond the congressional races, Nov. 3 saw gubernatorial elections in a number of states. Election outcomes could influence decisions on permitting and construction in some jurisdictions, but the implications for the pace and location of AI infrastructure development will vary by location and local dynamics.

We downgraded U.S. equities to neutral last month amid growing uncertainty over the speed, scale and economics of the AI buildout. We still believe in the transformative potential of AI, but questions remain over whether planned capital spending can be justified by future revenues and returns and whether current valuations adequately reflect those uncertainties. The answers to those questions are less clear than markets had assumed. Higher interest rates are increasingly differentiating companies by their ability to generate earnings and returns above the cost of capital. As the buildout becomes more debt-financed, leverage and funding costs are also coming into sharper focus. We still favor selective exposure to AI-related companies and listed infrastructure, where growing demand and scarcity in critical infrastructure can support attractive returns.

Alongside our downgrade of U.S. equities, we upgraded long-term U.S. Treasuries to neutral and short-term U.S. Treasuries to overweight after yields hit multi-decade highs. Higher yields now offer more attractive income and better compensation for underlying risks. The ebb and flow of AI investment expectations could ease or intensify competition for capital, driving swings in bond yields around structurally higher levels sustained by heavy government borrowing.

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